What is a conventional loan?

A conventional loan is a mortgage that’s available through and backed by a private sector lender.

They come in two main types: fixed-rate or adjustable-rate.

• Fixed-rate mortgages: Your interest rate never changes. You have the same monthly principal and interest payment for the length of the loan.
• Adjustable-rate mortgages: You’ll have a fixed introductory rate for the first three to 10 years of the loan. Then, the rate will change at preset intervals, such as every year or six months, based on an index rate plus a margin determined by the lender.

Conventional loan requirements

To be approved for any type of mortgage, you’ll need to meet the lender’s requirements around your financials, including your credit score, income and debts. Conventional loan requirements tend to be stricter than government-backed loan requirements. Specific qualifications include:

• Credit score: Mortgage lenders require a minimum score of 620 to qualify for a conventional loan. With a higher score, you’re more likely to get a better interest rate and terms.
• Debt-to-income (DTI) ratio: Your DTI ratio factors in other debts you have to pay each month, such as auto loans, student loans and credit card debt. Most lenders don’t want this ratio to exceed 43 to 45 percent.
• Down payment: While 20 percent down is the standard, many fixed-rate conventional loans for a primary residence allow for a down payment as small as 3 percent or 5 percent.
• Private mortgage insurance (PMI): If you put down less than 20 percent, you’ll have to pay PMI, an additional fee added to your payments. The average monthly cost of PMI is 0.46 percent to 1.5 percent of the loan amount, according to the Urban Institute.
• Loan size: Most conventional loans are also conforming loans: that is, they conform to Federal Housing Finance Agency (FHFA) limits on how much you can borrow. These limits vary based on where the property is located. In most of the U.S., the limit for 2024 is $766,550. Certain states (like Alaska and Hawaii) and higher-priced areas (including parts of California) have limits of $1,149,825.

Types of conventional loans

Conforming loans

Mortgages that fall within the FHFA’s limits are called conforming loans. This means Fannie Mae and Freddie Mac, two government-sponsored enterprises, can buy them on the secondary mortgage market. By selling these types of loans to Fannie and Freddie, lenders obtain the capital to continue to make new mortgages.

All conforming loans are conventional loans, but not all conventional loans are conforming loans. For example, if you get a jumbo loan — one whose size exceeds the FHFA limits — from a private bank, it would be a nonconforming conventional loan.

Jumbo loans

Mortgages that exceed conforming limits are called jumbo loans. A type of nonconforming loan, these are loans that can’t be sold to Fannie or Freddie, but they are still available to well-qualified borrowers who need a more flexible financing option. Jumbo loan rates tend to be higher than what you’d see with a smaller mortgage, though the gap has been closing in the last few years.

Non-qualified mortgages

Non-qualified mortgages, or non-QM loans, also cannot be purchased by Fannie or Freddie. But they can be an option for those who are able to afford a mortgage but maybe are unable to meet the credit or DTI requirements. These borrowers tend to fall outside of the “ability to repay” guidelines established by the Consumer Finance Protection Bureau after the 2008 financial crisis, which indicate whether a borrower is likely to repay a mortgage.

One type of non-QM loan could be a portfolio loan. With this kind of loan, a lender keeps the mortgage on its books, rather than sell it. Because it doesn’t have to meet conforming loan standards, the lender can be more flexible when qualifying a borrower. It’s important to note, though, that non-qualified mortgages often come with higher interest rates.

Subprime loans

Subprime loans are generally for borrowers with lower credit scores (typically below 600) who can’t qualify for a conventional mortgage. Subprime loans tend to have higher interest rates and larger down payment requirements than conventional loans to compensate lenders for accepting added risk.

Adjustable-rate loans

Fixed-rate loans keep the same interest rate — and same payment — over the life of the loan. An adjustable-rate mortgage (ARM) usually starts with an introductory “teaser” rate for the first few years. After that, the interest rate fluctuates periodically, so your monthly payment can go up or down.

Amortized conventional loans

Amortized loans have set, periodic payments that go toward the principal and interest until the loan balance is zero. While the monthly payment stays the same, you pay more in interest than principal at first and gradually shift to paying more principal than interest over time.